Background information:
In the early 2000s, many corporate entities around the globe faced various degrees of corporate scandals. A critical survey of these incidents revealed and linked their challenges to “fraudulent financial reporting” and the failure to adhere to basic corporate governance principles, which ultimately led to their downfall.
Within the Nigerian business landscape, corporate governance infractions were reported as early as the 1990s and continued into the 2000s and even up to 2020. These incidents involved notable financial institutions and other corporate entities, resulting in the premature dissolution of bank boards of directors (BODs) before the expiration of their legal tenure. Globally, history recorded cases where top executives at the Houston-based energy company Enron colluded with the once-reputable accounting firm Arthur Andersen to hide billions in debt generated from failed projects, using “fraudulent financial reporting mechanisms.” The resulting bankruptcy was one of the largest in U.S. history. Other global corporate scandals included MCI, Tyco, Adelphia, Peregrine Systems, WorldCom, ES Bankest, Cadbury Schweppes, Freddie Mac, Maxwell, Polly Peck, BCCI, Satyam, Bernie Madoff, Lehman Brothers, Parmalat, Xerox, and Walmart, among others.
These companies exhibited red flags such as high debt profiles, capital mismatches or negative working capital, share price manipulation, falsification of accounting information, poor risk management structures, weak or absent internal controls, repeated operating losses, diminishing profitability, massive looting by management, granting unauthorised loans, financial fraud, abuse of office, corruption and bribery, embezzlement, revenue inflation, reporting fictitious assets, and audit failures on the part of external auditors.
Fraudulent financial reporting, also known as “Creative Accounting” or “Window Dressing,” is an unethical practice that involves altering, manipulating, or falsifying accounting figures to create a misleading impression. This practice is often intended to deceive financial statement users. Other reasons for this include inducing investors, reducing tax liabilities, seeking financial assistance from banks, covering fraudulent activities, satisfying management’s personal goals, manipulating share prices, meeting minimum regulatory standards, retaining leadership in competitive environments, resisting takeover bids, and seeking financial rewards.
Solutions to fraudulent financial reporting:
Addressing fraudulent financial reporting involves a range of measures, including establishing strong financial management and control mechanisms, strict adherence to corporate codes of ethics, ensuring supervisory and oversight functions by BODs, and strengthening accounting and reporting practices. Additional measures include enhancing audit supervision, promoting strong internal control procedures, implementing strict codes of conduct for finance professionals, enforcing sanctions on defaulters, and promoting Internal Control over Financial Reporting (ICFR) as a means to combat creative accounting globally.
Origin of ICFR:
Following numerous corporate scandals in the early 2000s, including in the U.S., the American government enacted the Sarbanes-Oxley Act (Sarbox or SOX) on July 30, 2002, signed into law by President George W. Bush to promote transparency, accountability, investor protection, and financial market integrity. In Nigeria, the Federal Government responded by enacting the Investment and Securities Act (ISA) of 2007 and promoting compliance with guidelines issued by the Financial Reporting Council of Nigeria (FRCN) on December 29, 2022. Sections 60–63 of ISA 2007 mandate public companies to establish and report on ICFR activities.
ICFR defined:
Internal Control Over Financial Reporting (ICFR) is a framework comprising processes, personnel, and technology established by those governing an entity to ensure that its financial reporting is accurate, reliable, and compliant with relevant policies and regulatory frameworks.
The FRCN guidelines require both Public Limited Companies (PLCs) and Public Interest Entities (PIEs) to address ICFR-related issues. PIEs include concession entities, privatised companies with government interest, government licensees, public limited companies, holding companies of public or regulated entities, listed entities on Nigerian exchanges, regulated non-listed entities, and other entities engaged in government-funded public works exceeding a contract sum of #1 billion or with annual turnovers above #30 billion.
ICFR stakeholders:
For effective ICFR implementation, key stakeholders include top management (CEO/CFO), BODs, internal and external auditors, and ICFR consultants. Each party must actively contribute to this process to drive ICFR effectively within an organisation.
Benefits of ICFR:
The ICFR model focuses on five core areas: Control Activities, Risk Assessment, Information and Communication, Monitoring Activities, and Control Environment. It brings numerous benefits, including ensuring the integrity of an organisation’s financial records, protecting the interests of financial statement users, and promoting global best practices (such as the SOX guidelines, COSO framework, and corporate governance principles). Additionally, ICFR minimises errors and fraud, provides accurate data for decision-making, serves as a cost-saving tool by streamlining audit costs, promotes standardisation and data analysis, and enhances accountability and transparency, thus boosting public confidence in an entity’s operations.
Kingsley Ndubueze Ayozie, MSc (Finance), MBA, KJW, ACSI (UK), FCTI, FCA, is a Public Affairs Analyst and Chartered Accountant writing from Lagos.
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